Ethical Investing: Vehicles For Ethical Investing

The types of vehicles available to socially responsible investors are the same as those available to all investors: stocks, mutual funds, exchange-traded funds (ETFs), bonds, real estate, hedge funds and so on. However, socially responsible investors screen these vehicles differently than investors with a broader focus. They can also choose from vehicles specifically geared towards the socially responsible investor, like socially responsible mutual funds and ETFs. Let's evaluate the options.

Socially Responsible StocksInvesting in individual stocks, as a socially responsible investor, is one of the most labor-intensive investing methods out there. Typically, someone who invested in individual stocks would analyze the company's annual reports, and perform ratio analysis to determine if a stock had profitability potential. He or she would also stay on top of its current performance, and the company's new developments to determine if any changes warranted buying more stock or selling existing holdings.

In addition to screening for financials, socially responsible investors have to screen for ethical criteria, and it's not always easy to uncover all the details required to make the most informed decision about a company. Investors whose portfolios consist of individual stocks, also, must pay special attention to diversification - buying stocks that are concentrated in just one or two industries can make a portfolio highly volatile. Also, investors who make small purchases, or trade frequently, will pay lots of commissions, which can create a serious drag on returns.

However, for investors who have the time and are willing to put in the effort, investing in individual stocks provides a high level of control in ensuring that every investment meets ethical screening criteria. Also, value investors, who have historically achieved some of the highest stock market returns, tend to be individual stock investors.

Socially Responsible Mutual FundsA socially responsible mutual fund will invest in anywhere from a handful to hundreds of companies that meet specific ethical criteria. If you buy just one share, of a mutual fund, you'll own a small percentage of numerous stocks, whereas if you buy just one share of a stock, you're only exposed to one company.

When you invest in a socially responsible mutual fund, you'll have to decide whether you're comfortable taking the investment company's word that the fund meets the ethical criteria it says it does, or whether you want to thoroughly research it to make sure you agree. If you're going to spend the time researching each of the individual stocks that the mutual fund invests in, you're creating even more work for yourself than if you were to invest in individual stocks. It's probably a better use of your time to thoroughly research a few mutual fund companies, and when you find one or more that you trust, let them do the work for you.

Mutual funds often have minimum investment thresholds, such as $2,500 or $10,000, which can be difficult for beginning investors to meet. But, when you buy mutual funds directly from the brokerage that issues them, you won't pay commissions on your trades. On the other hand, the ongoing costs of owning a mutual fund can be more expensive, over time, than buying and holding individual stocks and paying very infrequent trading commissions. (Learn more in our article on Socially Responsible Mutual Funds.)

Socially Responsible ETFsMutual funds have begun to take a back seat to ETFs because, broadly speaking, ETFs are easier to trade and have lower expenses. Since expenses are the most reliable indicator of mutual fund performance, according to Morningstar.com, it makes sense that investors are leaving mutual funds in favor of ETFs.

Socially responsible ETFs are put together in a similar manner as socially responsible mutual funds. However, they trade like stocks, so rather than needing, say, $2,500 to start investing, you can start investing in ETFs for as little as the cost of a single share, plus the trading commission. ETFs can also be more tax efficient than mutual funds, which matters if you're investing outside of a tax-advantaged retirement account.

Socially Responsible BondsYou might consider some types of bonds to be socially responsible. You could invest in corporate bonds, which allow companies to borrow money from investors, or you could invest in municipal bonds, which fund local government projects and which some people view as a form of community development. You can also invest in bonds through mutual funds and ETFs rather than buying individual bonds. Bonds help to diversify a portfolio based on stocks and can smooth out fluctuations in portfolio value.

Real EstateIf you're extremely picky in your ethical investment criteria, real estate could be a great choice. You'll have a ton of control over what property to invest in and how to manage it.

Real estate investing can be an especially logical choice for environmentally conscious investors, as owning property lets you make daily decisions that affect your environmental impact. It's also a sensible choice for other types of ethical investors, because property ownership doesn't require you to worry about corporate governance or sweatshop labor (except in the purchasing decisions you make when operating, maintaining, remodeling or furnishing your property). You can also use real estate investing to support community development.

Government regulations often get in the way of private property rights. So, if you have specific plans for making a property environmentally responsible, check on local, city, state and federal regulations before you buy. For example, if you want to buy a home and install solar panels, make sure it's allowed and you can afford any required installation permits.

A potential pitfall with owning property is that the operating and upkeep expenses, and the interest expenses, if you have to borrow money to purchase the property, can create a serious drag on any potential returns. Owning real estate also makes you susceptible to certain types of lawsuits (e.g., someone sues you because they get injured on your property).

If you're not comfortable with all of the responsibilities associated with property ownership, or don't have enough money to get started, you can gain exposure to real estate through other methods, such as real estate stocks and real estate investment trusts. (For more, see Diversifying Your Portfolio With Real Estate And Infrastructure.)

Hedge FundsHedge funds are only an option if you meet the SEC's criteria for being an accredited investor. Hedge funds often employ high-risk strategies with the intention of achieving high returns. High-risk might mean the use of investment techniques that most people don't understand, or investing in opportunities that aren't available to most people.

Some hedge funds focus on shareholder activism. So, if you've been looking for the kind of strength in numbers that can convince a company to change its behavior, a hedge fund might be your answer. Hedge funds can have expensive management and performance incentive fees, though, so make sure you understand what you're paying for before you invest. (Learn more in Evaluating Hedge Fund Performance.)

Don't Forget the BasicsNo matter which investment vehicle you choose, you can't overlook fundamentals, just because an investment is ethical. If you're investing in mutual funds, you can't ignore expense ratios; if you're investing in real estate, you can't ignore location. Ethical investment doesn't substitute one set of investment criteria for another - it adds a new level of investment criteria to an existing level.

You'll also have to confront the issue of whether buying into a socially responsible investment, issued by a company that caters to everyone is good enough, or whether you're only willing to work with companies that exclusively deal in socially responsible investments.